When TS Eliot called April the cruellest month he worked at a bank – perhaps he might have called August the most fragile.

Raghuram Rajan (Getty Images)

World wars have a habit of starting at about this time of year and seven years ago this month the banking crisis hit.

So when two of the world’s top central bankers warn – in that usually most staid of magazines, the Central Banking Journal – that we are heading for another crash it is time to put on the flak jackets.

Raghuram Rajan, the governor of the Reserve Bank of India, warns that global markets risk another almighty crash if investors start bailing out of risky assets created by the loose monetary polices of the more developed countries. He said: “The kind of language we hear is akin to gaming.”

The former chief economist of the International Monetary Fund ads that most economists have not learnt the lessons of the most recent financial crisis and are not spotting the build-up in risk.

As Rajan was one of the few economists who did predict the last crash, as early as 2005, we should sit up. He told the CBJ: “Financial sector crises are not as predictable. The risks build up until, wham!, it hits you.
“The concern is that central banks may be exhausting room on the financial side and creating a situation where there will be a discontinuous movement in the financial sector. That is my worry. We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost.”

Rajan suggests that the risks are likely to be in “shadow banking”, rather than the formal banking sector to which the authorities have devoted much more regulatory effort since the crisis. “We haven’t done a lot on the shadow-banking system,” he said. “But ordinary pension funds and mutual funds could be taking on some of these risks. So I worry about that.”

If you think Rajan is being scary, listen to Andy Haldane, chief economist at the Bank of England and its former executive director of financial stability, who warns that the massive build-up of risky assets on the balance sheets of financial institutions like insurance companies and pension funds that lie outside the banking sector could be the cause of the next crash.

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He worries that risk is migrating outside the banking system: “And with that move, risk may itself change shape and form. What had been credit and maturity mismatch risk on the balance sheet of the banking system may metastasise into market and illiquidity risk on the balance sheets of non-banks.” As money flows in and out of the swelling mountains of assets in pension funds and insurance companies, prices will dip or spike with severe implications for the stability of the financial system and the broader economy.

For those away on the beaches, it is worth reporting what Haldane says at length as it is so pertinent: “Risk, like energy, tends to be conserved not dissipated ... So it is possible the financial system may exhibit a new strain of systemic risk – a greater number of higher-frequency, higher-amplitude cyclical fluctuations in asset prices and financial activity, now originating on the balance sheets of mutual funds, insurance companies and pension funds.

“These cyclical fluctuations could in turn be transmitted to, and mirrored, in greater cyclical instabilities in the wider economy.”

Let’s hope Rajan and Haldane are right that the banking system is stronger than it was. It should be: banks are spending around $70 billion a year on better regulation, compliance and risk management. The chairman of HSBC, Douglas Flint, disclosed last week that the bank spent around $800 million on regulatory and compliance costs last year, including the recruitment of around 1,750 staff, up from $200 million the year before.

No wonder: HSBC had to pay a $1.9 billion fine in the US for handling drug money from Mexico, was caught transmitting funds from Iran and was involved in the mis-selling of PPI and interest-rate swaps. It faces investigations on Libor and the foreign exchange market. Yet Flint had the gall to complain about the costs of regulation.

More worrying was his call on Chancellor George Osborne to delay the rules on ring-fencing of retail banking from other operations, due to be in force in 2019, because of other inquiries taking place that may change the bank’s structure. If HSBC is that worried by the complexity of its businesses, then it needs to slim down some more.

It is too early to know whether the banking system has toughened up enough. What is clear is that the regulators and politicians must pay heed to Rajan and Haldane and start peering more closely into the shadows of the financial sector if we want to avoid a repeat of the Queen’s memorable question about the crash: “Why did nobody see it coming?” At least two very well placed people do now.

This article first appeared in the print edition of Financial News dated August 11, 2014